Vox Clamantis in Urbe. The Sources of Income Inequality

by Jacob Oppenheim

Let us return to the world of the 1950s, a time of significantly lower income inequality. Commentators frequently hearken to this time of high wages and good manufacturing jobs for the uneducated as a lost Eden. Such an analysis forgets the massive social repression that was part and parcel of this condition. By limiting employment to white men and keeping out nearly all unskilled immigrants, the demand for labor led to relatively high wages. While labor unions were able to negotiate lucrative contracts for their workers, throughout the North, they excluded African-Americans from becoming members. As union membership was a requirement for these jobs, blacks in the postwar North did not benefit. In the South, Jim Crow laws successfully kept blacks semi-enserfed as agricultural laborers. Restrictive immigration policies put into place in 1922 limited migration from everywhere but Western Europe, stemming the early twentieth century flood of unskilled migrants from Eastern and Southern Europe and from East Asia. Let us not forget that half of the population (women) essentially did not work after marriage. The jobs that women did take were limited to teaching, nursing, and secretarial work, keeping wages low in these fields, and high for men in more lucrative positions.

It was the collapse of these three social and legal barriers—against African-Americans, foreign unskilled labor, and women—that caused much of the resulting increase in income inequality. As the supply of labor increased for jobs formerly held by white men, less educated workers’ wages fell relative to their more educated peers. It is worth noting that in fields formerly dominated by women, such as nursing, wages rose since employers had to compete for workers who had many more potential occupations. While the unnaturally high working- and lower-middle-class wages of the 1950s led to dramatically lower income inequality, wages across the board have risen substantially since then as discriminatory barriers have fallen. We should have no desire to return to the world of the ‘50s, nor should we use them as a benchmark for measuring income inequality.

In parallel with the end of discriminatory barriers to employment, several other causes of income inequality are benign as well. One example is that of immigration. Millions of immigrants, both legal and, until recently, illegal, enter the United States every year. The majority are unskilled and enter at the bottom of the economic ladder. While they and their descendants grow wealthier and more successful, the refreshing of untrained and poorly educated workers ensures a continuous and relatively large (in comparison with other developed nations) population at the bottom of the income distribution. Given that these immigrants grow wealthier over time and that they are nearly always better off in income than in their native countries, this effect is no cause for concern. Indeed, studies have shown that increased unskilled immigration increases the wages of native, unskilled workers, by placing a premium on their being natives. That is, an increase in Latino immigrants willing to work as gardeners increases the wages of American-born high school dropouts, who are needed as better-paid supervisors rather than as gardeners themselves.

Globalization is a second source of income inequality, but not in the way that is commonly presumed. While offshoring of manufacturing exerts downward pressure on wages, it also increases employment opportunities in more lucrative professions as well as dramatically decreasing the price of everyday goods. Rather, globalization has greatly increased the returns to talent. Successful businessmen now have access to the world market as opposed to just a national, or regional one. They are thus able to command significantly higher salaries. A simple example comes from Sweden, where income inequality has risen in parallel to that in the United States, despite a much more activist state and dramatically higher taxes. Companies like H &M and IKEA are able to open stores overseas, making much more money than they could in Sweden alone. One billion potential customers provide considerably more revenue than eight million. The success of IKEA has led to more and better jobs in Sweden as well as high wages for its top management, thus appearing as an increase in income inequality. Such changes that enhance everyone’s welfare should not concern us.

It is also worth considering the increasing number of well-educated people who choose to work fewer hours and devote themselves to their families, hobbies, or a poorly paying profession, like artisanal pickle production. Every such person shows up as an increase in income inequality, by shrinking the numbers of the wealthy and nearly wealthy. Had these people worked harder at the most lucrative jobs they could find, the distribution of income would be flatter.

Lastly, it is frequently pointed out that men’s wages have been stagnant or falling since the late 1970s. These statistics neglect the cash value of health insurance, which is still provided to most Americans by their employers, and whose costs have been rising at 5-13% per annum for 40 years. Once the cost of health insurance is added back in, men’s wages have grown, just not particularly quickly. Women’s wages, however, continue to rise.

The sources of inequality listed above account for somewhere between two-thirds and three-quarters of the observed increase since the late 1950s. They have been observed throughout the west even in the semi-socialist states of Europe, and cannot be prevented by higher taxes and greater government spending. Given these numerous beneficial and benign causes, what is it about income inequality that irks us?

What galls us is the enormous salaries earned in the financial services sector and by the upper management at some (but not nearly all) large corporations. If it appeared that the highest wages were found in productive industries that had not needed bailouts less than 4 years ago, we would find less to complain about. Unlike the pay of upper managers, which seems to be falling due to disclosure laws and mandatory “say on pay” votes, the problem of enormous profits accruing to Wall Street through oligopolistic behavior and corporate strategies dependent on a government bailout — what economist Tyler Cowen terms “going short on volatility”—are the cause of income inequality we can and should control.

Income inequality thus exemplifies why a scientific mindset is necessary in policy debates. Our dependent variable is income inequality, but to assume prima facie that it can be corrected by taxes and transfers is silly and useless, once we examine its proper, and decidedly nonobvious causes. (For one thing, it wouldn’t have led to the extremely effective “say on pay” law and increased shareholder rights.) What should trouble us is our inability to properly reform Wall Street and remove the implicit government subsidy for its activities. As for the rest of it, who cares what other people earn? As Mitt Romney put it, it is “the politics of envy.”

1. Or in the case of healthcare, orthogonal to nearly all proposals and hand wringing about income inequality.

September 2012

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